Multi Commodity Exchange of India Ltd. Stock Update Multi ...

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Multi Commodity Exchange of India Ltd.

Stock Update Multi Commodity Exchange of India Ltd.

October 04, 2021

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Our Take:

MCX has a near monopoly in commodity exchange business with ~92.6% market share as on Q1FY22. The exchange has been facing headwinds since past few years due to Covid-19 lockdown, crude impact, subdued trend in Gold prices and SEBI’s new margin rules. However we feel that worst in terms of volume growth is over and things could start improving in near term. We believe volumes would recover with increase in algo trading, pick-up in crude volume (reduction in margin) and implementation of cross margin benefits. The company has recently launched a few new products. Permission to DIIs to participate in commodity markets was one of the significant measures. Approval of Index derivatives will aid the growth of Institutional participation which in turn could bring large volumes on the exchange. Recent traction in option volumes is noteworthy; the company will start charging for options contracts effective Oct-21. The shift to the new trading platform will result in cost savings, leading to a ~260bps margin tailwind in FY23E. We had issued Initiating Report on MCX on 14th September, 2020 and recommended Buy at LTP and add on dips to Rs.1375-1385 band, for base case target of Rs.1729 and bull case target of Rs.1839 over the next two quarters. The bull case target of Rs.1839 was achieved on the same day itself, yielding return of 18.3%. Link for the Initiating Coverage: https://www.hdfcsec.com/hsl.research.pdf/MCX%20-%20Initiating%20Coverage%20-%2014092020.pdf

Valuation & Recommendation: We expect MCX to post 25.7% EBITDA CAGR, driven by revenue CAGR of 14% over FY21-23E. Net profit is envisaged to grow by 16.3% CAGR over same time frame. EBITDA margin is estimated to reach to 57.6% in FY23E vs 47.4% in FY21. We expect volume decline trend to be over and it will start to recover from here on aided by higher volatility in Gold and Crude oil prices. Considering the asset-light nature of the business, we expect RoE to recover to 20.3% in FY23E vs 16.2% in FY21. Considering the way the exchange and depository stocks have go rerated recently (as platform companies) and the rise in unofficial rates for NSE stock, we think MCX is likely to get rerated soon given its free cash flow, balance sheet-light business with a 90% dividend payout. A high quality monopoly exchange with high structural growth and cyclical resilience deserve higher multiples. MCX currently trades at 38.3x FY22E and 28x FY23E EPS. Detailed SOTP calculation is shown in below table.

Industry LTP Recommendation Base Case Fair Value Bull Case Fair Value Time Horizon

NBFC-HFC Rs.1672 Buy at LTP of Rs.1672 & add more on dips of Rs.1504 Rs.1825 Rs.1953 2 quarters

HDFC Scrip Code MCXLTDEQNR

BSE Code 534091

NSE Code MCX

Bloomberg MCX

CMP Oct 01, 2021 1672

Equity Capital (Rs mn) 510

Face Value (Rs) 10

Equity Share O/S (mn) 51

Market Cap (Rs bn) 85.27

Book Value (Rs) 278.6

Avg. 52 Wk Volumes 690527

52 Week High 1875.0

52 Week Low 1,434.8

Share holding Pattern % (Jun, 2021)

Promoters -

Institutions 75.96

Non Institutions 24.04

Total 100.0

* Refer at the end for explanation on Risk Ratings

Fundamental Research Analyst Nisha Sankhala

[email protected]

https://www.hdfcsec.com/hsl.research.pdf/MCX%20-%20Initiating%20Coverage%20-%2014092020.pdf

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We believe that investors can buy MCX at LTP of Rs. 1672(31.5xCore EPS + Cash) and add more at Rs.1504 (27.5xCore EPS + Cash) for the base case fair value of Rs.1825 (35xCore EPS + Cash) and for the bull case fair value of Rs.1953 (38xCore EPS + Cash) over the next two quarters. Financial Summary

Particulars (Rs mn) Q1 FY22 Q1 FY21 YoY (%) Q4 FY21 QoQ (%) FY20 FY21 FY22E FY23E

Net Revenues 876 730 20.0 970 (9.7) 3,978 3,906 4,025 5,074

EBITDA 369 265 38.9 443 (16.7) 1,784 1,852 1,857 2,924

APAT 398 564 (29.5) 384 3.5 2,365 2,252 2,217 3,044

Diluted EPS (Rs) 7.8 11.1 (29.5) 7.6 3.5 46.5 44.3 43.6 59.8

P/E (x) 36.0 37.7 38.3 28.0

EV / EBITDA (x)

41.0 39.1 38.5 24.2

RoE (%) 18.1 16.2 15.4 20.3 (Source: Company, HDFC sec)

Recent Developments Q1FY22 Result Update

Revenue for the quarter came at Rs. 876 mn, up 20% YoY and down 10% QoQ. EBITDA margin stood at 42.1%, down 358bps QoQ, on account of lower revenue and higher employee expenses. EBITDA increased by 39% to Rs.369 mn for Q1FY22 from Rs.265 mn over the corresponding quarter of FY21, while net profit at Rs. 398 mn declined by 30% YoY. The company has planned to use Rs.120 mn MAT credit of FY21 in FY22 and it should converge to normal tax rates from FY23E onwards. The total traded value was at Rs.17.73tn (-10.6/+25.7% QoQ/YoY) and ADTV stood at Rs.277bn (-12.0/+19.8% QoQ/YoY). Bullion/energy/metals/agri ADTV was down 22.1/2.2/2.4/2.9% QoQ respectively. ADTV declined sequentially for the third consecutive quarter due to an increase in upfront margin requirements. Active UCC was up 16/79% QoQ/YoY, indicating higher retail participation. New Unique Client Codes (UCCs), have more than doubled in the last 5 quarters. Volume from algo channel was at around 40-45% of total trades. Option volumes have been gaining traction since past couple of quarters. The company has also launched silver mini options contracts. Post Q1 also the volumes have kept on declining. Compared to Q1FY22 ADTV of Rs.277bn, Aug-21 ADTV came in at Rs250bn and that in Sep-21 ADTV has been around Rs231bn. The volumes of key commodities have trended lower. However, option volume has shown

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resilience led by crude oil, which has contributed ~70% to total options volume in FY22 so far. Note that September is the fourth and the last stage of the new SEBI margining rules being implemented.

New Product launches

As and when derivative trading on electricity is permitted, MCX would have the opportunity to launch electricity derivative contracts,

subject to regulatory approvals, and serve the stakeholders in the Indian electricity industry. Towards this objective, MCX entered into a

licensing agreement with Indian Energy Exchange (IEX) to use their spot prices as the underlying for the MCX electricity derivatives, when

they are traded after receiving requisite approvals.

During FY21, MCX introduced products in new categories such as Options in Goods and Commodity Indices. The company is looking forward

to launch more products in these new categories, subject to market demand and feedback. In FY21, MCX and Mjunction Services Ltd agreed

to enter into a Memorandum of Understanding with the objective of jointly exploring business opportunities and capitalizing on the

synergies of the two companies by setting up a joint venture for running a coal exchange. Further, management has also informed that they

are looking forward to regulatory reforms that can lead to opening of new opportunities, such as ETFs in many more commodities and their

derivatives, apart from the currently-permitted ETFs in gold futures.

SEBI has recently approved framework for Gold spot exchange. MCX could be one of the first exchanges to take advantage of this

development.

Monthly ADTV (Rs bn)

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Shift to the new trading platform

MCX is developing new software with TCS, for which the first drop has been delivered. The second and third drops should be delivered

subsequently. Management expects to go live with the platform from September 2023. Annual maintenance charges (AMC) would be small

component and the total cost of software will be amortized over six years. The shift to the new trading platform could result in cost savings,

leading to a ~260bps margin tailwind in FY23E. Currently, technology costs are at 14-15% of transaction revenues.

The company will start charging for options contracts effective Oct-21

In 2017, the company has launched options contracts on commodities futures. Recently these have gained popularity and the volume has

started to improved (accounting for >30% of the futures turnover). Among these, all crude-oil contracts have received more traction as the

margin requirement on crude oil future contracts is one of the highest. Now the company has decided to start charging Rs.50 per Rs.1 lakh

(up to Rs.50 mn and if it exceeds beyond that it will be Rs.40) of the premium value from 1st October 2021. This will add new earning

avenue but at the current level this is insignificant.

Implementation of cross margin rules for index futures

SEBI’s has given approval for cross margin benefit on index futures versus the underlying commodities futures. Cross margining allows

market participants to reduce the total margin payment required if they are taking two mutually offsetting positions. The move helps

market participants transfer excess margin from one account to another. This will also reduce the cost of trading and boost liquidity in such

products. This over the long run could benefit the exchanges such like MCX as it could bring higher volumes.

Options ADTV (Rs bn)

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Index derivatives could aid growth of Institution participation

Permission to domestic financial institutions to participate in commodity markets was one of the significant measures as the entry of

institutional participants can boost depth and volumes, spur retail participation and ease the access of small stakeholders, including the

hedgers, to the hedging and investment platform of commodity exchanges. The initial participation of institutional investors has remained

low but the potential is huge. Globally Institutions account for ~50% of the total commodity derivatives volume.

The Exchange had received permission from SEBI and has launched futures on indices like iComdex Bullion (for precious metals like Gold

and Silver) and iComdex Base Metals (five metals – copper, aluminum, lead, nickel and zinc). Recently, approval for launch of iCOMDEX

Energy Index (ENRGDEX) was also received. This will aid the growth of Institutional participation which in turn could bring large volume on

the exchange.

Worst impact of new margin rules is behind us

The exchange has been observing headwinds since past few years. Covid-19 lockdown and crude oil volatility impact had affected H1FY21

resulted and after that the SEBI’s new margin rules has created additional pressure on volume growth. To ensure smooth transit,

implementation was done in four phases (with rising margin requirements). A significant drop in volumes is seen in Sep-21, as the fourth

and the last stage of the new rules is being implemented. Q1FY22 was the third consecutive quarter of declining ADTV sequentially.

However, as time passes we believe that the impact will start fading off and aided by lower base we could see a decent growth in volumes.

Recent high volatility in metal and energy products and expected volatility in Gold and Crude oil could drive volume growth. The

management has also indicated that the volume impact due to regulatory changes was only ~3% in phase-3 vs. ~20% in phases 1 and 2.

Probable reduction in crude oil trading margin and Mutual funds launching schemes including commodities are some other triggers for

MCX.

MCX’s volume trend

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Risks & Concerns

Any adverse change in regulations could hurt the business in major way.

High competition from other exchanges, especially after permitting of trading of commodity derivatives on NSE/BSE.

Cybersecurity threat is becoming more and more critical with technological advancements. Measures to tackle competition and changes in latest technology are important in this business. MCX is also developing new software with TCS.

The possibility of third wave and fresh lock downs could hurt the business as volumes are closely linked with economic conditions both the domestic and the global.

As the Exchange’s transaction fee is calculated on the basis of the value of commodity futures contracts traded on the Exchange, the volume and value of contracts traded on it have a direct impact on MCX’s revenues. Falling prices of base metals and bullion could impact its revenues adversely.

This business has inherent risk of volatility. Market volatility (especially downward) has high correlation with volumes growth. So any prolonged period of negative returns from commodities market can hurt company’s revenues hard.

MCX may have to take an Rs18.8 cr write-off of the investment in a spot trading system following non-fulfilment of conditions. Company Background: Having commenced operations on November 10, 2003, Multi Commodity Exchange of India Limited (MCX) is India’s first listed, national-level, electronic exchange. It is also the first exchange to introduce commodity options in India. The market share of MCX stood at 92% in commodity futures segment. MCX offers the benefits of fair price discovery and price risk management to the Indian commodity market ecosystem. Various commodities across segments are traded on the Exchange platform. These include bullion, energy, metals and agri commodities. The exchange has forged strategic alliances with various international exchanges, as well as Indian and international trade associations.

The Company has a national reach with 620 members, having 48,427 Authorised Persons, operating through 42.5 lakh terminals connected through various available modes of connectivity (including Computer to Computer Link (CTCL), Internet Based Trading and Wireless Trading) across 1,000 cities/towns across India. Unique Client Code (UCC) is 69.86 lakh.

Peer comparisons

Company MCap

CMP (Rs) P/E (x) Dividend Yield (%) RoE (%)

(Rs bn) FY21 FY22E FY23E FY21 FY22E FY23E FY21 FY22E FY23E

MCX 85.3 1672 37.7 38.3 28.0 2.0 2.0 2.7 16.2 15.4 20.3

BSE 54.83 1218 31.3 21.8 18.1 1.7 2.9 3.7 7 9.8 11.5

CDSL 134.8 1290 69 48 40 0.8 0.7 0.9 22.8 27.8 27.9

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SOTP Valuations:

Quarterly trend analysis:

Base Case Bull Case

Core PAT FY23E (Rs mn) 2,177 2,177

Core P/E Multiple (x) 35 38

Core Mcap (Rs mn) 76,206 82,738

Add: Net Cash (Rsmn) ex SGF 16,646 16,646

Target Mcap (Rs mn) 92,852 99,384

Target Price (Rs) 1,825 1,953

MCX ADTV (Rs bn) Q1FY19 Q2FY19 Q3FY19 Q4FY19 Q1FY20 Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 Q1FY22

Bullion 55.2 54.7 59.0 66.8 74.1 131.6 101.7 141.2 131.9 243.8 168.8 154.5 120.3

Energy 79.8 79.8 113.5 108.5 120.1 144.0 153.2 170.3 58.1 65.5 78.9 83.4 81.6

Metals 104.6 108.3 89.7 90.3 75.7 67.0 50.4 49.7 39.0 68.0 66.6 70.9 69.2

Agri & others 4.0 3.8 3.9 4.1 4.7 2.7 3.2 5.0 2.3 3.0 4.3 6.2 6.0

ADTV 243.6 246.5 266.1 269.8 274.7 345.3 308.5 366.3 231.3 380.3 318.7 314.9 277.1

MCX Futures Volume (Rs bn)

Q1FY19 Q2FY19 Q3FY19 Q4FY19 Q1FY20 Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 Q1FY22

Bullion 3,587 3,498 3,775 4,278 4,671 8,551 6,611 9,322 8,048 16,093 10,972 9,730 7,700

Energy 5,188 5,107 7,266 6,946 7,569 9,358 9,960 11,243 3,542 4,323 5,130 5,256 5,223

Metals 6,801 6,932 5,740 5,782 4,771 4,355 3,277 3,279 2,378 4,487 4,332 4,467 4,427

Agri & others 257 242 251 262 297 177 206 329 141 199 280 389 383

Total Volume (Rs bn) 15,834 15,779 17,033 17,268 17,308 22,442 20,055 24,173 14,108 25,102 20,713 19,841 17,733

MCX QoQ % Q1FY19 Q2FY19 Q3FY19 Q4FY19 Q1FY20 Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 Q1FY22

Bullion 5.7% -1.0% 7.9% 13.3% 10.9% 77.4% -22.7% 38.9% -6.6% 84.8% -30.8% -8.5% -22.1%

Energy -6.0% 0.0% 42.3% -4.4% 10.7% 19.8% 6.4% 11.2% -65.9% 12.8% 20.5% 5.7% -2.2%

Metals 9.0% 3.5% -17.2% 0.7% -16.2% -11.5% -24.7% -1.5% -21.5% 74.4% -2.0% 6.4% -2.4%

Agri & others -22.3% -4.4% 3.8% 4.3% 15.3% -42.2% 16.2% 57.0% -53.4% 30.3% 42.5% 43.3% -2.9%

ADTV 2.2% 1.2% 7.9% 1.4% 1.8% 25.7% -10.6% 18.7% -36.9% 64.4% -16.2% -1.2% -12.0%

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Commodity Segment MCX Market Share in Indian Commodity Futures

Proportion of MCX’s turnover

Precious Metals & Stones 99.99% 43.62%

Energy 100.00% 29.11%

Base Metals 100.00% 25.13%

Agri- Commodities 21.16% 2.14%

Margin trend(%)

Mix Of Major Traded Commodities On MCX

Return Ratios(%)

No of UCCs (in mn)

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Financials

(Source: Company, HDFC sec)

Income Statement

Balance Sheet

(Rs mn) FY19 FY20 FY21 FY22E FY23E

(Rs mn) FY19 FY20 FY21 FY22E FY23E

Net Revenues 3,000 3,978 3,906 4,025 5,074 SOURCES OF FUNDS

Growth (%) 15.5 32.6 (1.8) 3.1 26.1 Share Capital 510 510 510 510 510

Software support charges 614 689 636 646 515 Reserves 11,999 13,084 13,672 14,133 14,798

Employee Expenses 725 773 751 813 879 Total Shareholders’ Funds 12,509 13,594 14,182 14,643 15,308

Tech & SG&A Expenses 205 206 211 226 244 Settlement guarantee fund 3,298 4,098 4,692 4,786 4,882

Other Operating Expenses 517 526 456 483 512 Net Deferred Taxes (Net) 14 18 22 22 22

EBITDA 940 1,784 1,852 1,857 2,924 Long Term Provisions & Others 401 528 554 554 554

EBITDA Margin (%) 31.3 44.8 47.4 46.1 57.6 TOTAL SOURCES OF FUNDS 16,221 18,237 19,451 20,005 20,766

EBITDA Growth (%) 30.7 89.9 3.8 0.3 57.5 APPLICATION OF FUNDS

Depreciation 154 182 221 244 269 Net Block 1,580 1,583 1,594 1,591 1,627

EBIT 785 1,602 1,632 1,613 2,655 CWIP 190 237 263 263 263

Other Income (Including EO Items) 748 1,053 1,038 1,093 1,059 Investments 123 123 124 124 124

Interest 0 2 3 3 3 LT Loans & Advances 614 708 667 701 736

PBT 1,533 2,653 2,667 2,703 3,712 Total Non-current Assets 2,506 2,651 2,649 2,679 2,750

Tax (Incl Deferred) 75 289 415 487 668 Debtors 60 65 90 66 83

Minority Interest & Associate profit 4.3 0.4 0.9 0.9 0.9 Other Current Assets 945 753 948 772 973

RPAT 1,462 2,365 2,252 2,217 3,044 Cash & Equivalents 17,243 23,878 21,339 22,238 24,141

EO (Loss) / Profit (Net Of Tax) -238 0 0 0 0 Total Current Assets 18,248 24,695 22,377 23,076 25,198

APAT 1,700 2,365 2,252 2,217 3,044 Trading margin from members 3,518 7,599 4,175 4,141 5,330

APAT Growth (%) 56.9 39.1 (4.8) (1.5) 37.3 Other Current Liabilities & Provns 1,016 1,510 1,400 1,610 1,851

Core PAT (ex other income) 747 1,428 1,377 1,322 2,177 Total Current Liabilities 4,533 9,109 5,575 5,750 7,182

Core PAT Growth (%) 83.7 91.2 (3.5) (4.0) 64.6 Net Current Assets 13,715 15,586 16,802 17,326 18,016

Adjusted EPS (Rs) 33.41912 46.48 44.25 43.56734 59.8163 TOTAL APPLICATION OF FUNDS 16,221 18,237 19,451 20,005 20,766

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Cash Flow Statement

Key Ratios (Rs mn) FY19 FY20 FY21 FY22E FY23E

FY19 FY20 FY21 FY22E FY23E

Reported PBT 1533 2653 2667 2703 3712

PROFITABILITY (%)

Non-operating & EO items -954 -1224 -981 -1093 -1059

GPM 79.6 82.7 83.7 84 89.9

Interest expenses 0 2 2 3 3

EBITDA Margin 31.3 44.8 47.4 46.1 57.6

Depreciation 155 181 221 244 269

APAT Margin 56.7 59.4 57.7 55.1 60

Working Capital Change 2153 3402 -3274 343 1179

RoE 12.9 18.1 16.2 15.4 20.3

Tax Paid -295 -523 -479 -487 -668

RoIC (or Core RoCE) 17.7 25.4 23.4 23.4 31.2

OPERATING CASH FLOW ( a ) 2591 4492 -1844 1714 3435

RoCE 10.5 13.7 12 11.3 14.2

Capex -271 -277 -211 -241 -304

EFFICIENCY

Free cash flow (FCF) 2320 4215 -2055 1472 3130

Tax Rate (%) 4.9 10.9 15.6 18 18

Investments 0 0 0 0 0

Fixed Asset Turnover (x) 0.1 0.1 0.2 0.2 0.2

Non-operating Income 445 407 302 1093 1059

Debtors (days) 7 6 8 6 6

INVESTING CASH FLOW ( b ) 174 130 91 852 755

Other Current Assets (days) 115 69 89 70 70

Debt Issuance/(Repaid) 0 0 0 0 0

Other Current Liab & Provns (days) 277 388 392 434 532

Interest Expenses 0 0 0 -3 -3

Cash Conversion Cycle (days) -155 -313 -295 -358 -456

FCFE 2320 4215 -2055 1469 3128

Net D/E (x) -1 -1 -1 -1 -1

Share Capital Issuance 0 0 0 0 0

PER SHARE DATA (Rs)

Dividend -1045 -1230 -1530 -1663 -2283

EPS 33.4 46.5 44.3 43.6 59.8

FINANCING CASH FLOW ( c ) -1045 -1230 -1530 -1666 -2286

CEPS 36.5 50 48.6 48.4 65.1

NET CASH FLOW (a+b+c) 1719 3392 -3284 899 1904

Dividend 20 30 33.2 32.7 44.9

EO Items, Others -1258 3243 744 0 0

Book Value 245.9 267.2 278.6 287.7 300.8

Closing Cash & Equivalents 17243 23878 21339 22238 24141

VALUATION

P/E (x) 50.1 36 37.7 38.3 28

P/BV (x) 6.8 6.3 6 5.8 5.6

EV/EBITDA (x) 79.4 41 39.1 38.5 24.2

Dividend Yield (%) 1.2 1.8 2 2 2.7

One Year Price Chart

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HDFC Sec Retail Research Rating description Green Rating stocks This rating is given to stocks that represent large and established business having track record of decades and good reputation in the industry. They are industry leaders or have significant market share. They have multiple streams of cash flows and/or strong balance sheet to withstand downturn in

economic cycle. These stocks offer moderate returns and at the same time are unlikely to suffer severe drawdown in their stock prices. These stocks can be kept as a part of long term portfolio holding, if so desired. This stocks offer low risk and lower reward and are suitable for beginners. They offer

stability to the portfolio.

Yellow Rating stocks This rating is given to stocks that have strong balance sheet and are from relatively stable industries which are likely to remain relevant for long time and unlikely to be affected much by economic or technological disruptions. These stocks have emerged stronger over time but are yet to reach the

level of green rating stocks. They offer medium risk, medium return opportunities. Some of these have the potential to attain green rating over time.

Red Rating stocks This rating is given to emerging companies which are riskier than their established peers. Their share price tends to be volatile though they offer high growth potential. They are susceptible to severe downturn in their industry or in overall economy. Management of these companies need to prove

their mettle in handling cyclicality of their business. If they are successful in navigating challenges, the market rewards their shareholders with handsome gains; otherwise their stock prices can take a severe beating. Overall these stocks offer high risk high return opportunities. Disclosure: I, Nisha Sankhala, (MBA), authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. HSL has no material adverse disciplinary history as on the date of publication of this report. We also certify that no part of our

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